Advanced Search
MyIDEAS: Login to save this article or follow this journal

Generalized Asset Return Parity And The Exchange Rate In A Financially Open Economy

Contents:

Author Info

  • Alexis Derviz

Abstract

The paper studies the parity conditions between assets denominated in different currencies, traded in a wellintegrated segment of the international capital market, and derives the consequences for the exchange rate expectations. The main objective is to assess the uncovered asset return parity for the Czech koruna exchange rate. I argue that any reasonable decision-theoretical foundation of the uncovered parity condition should be formulated in terms of secondary market yields on long-term instruments and not the short-term money market rates. Specifically, the international version of the Consumption-based Capital Asset Pricing Model (CCAPM) is the universal (and, in fact, the single) message of any stochastic general equilibrium model of an open economy. Accordingly, I replace the traditional uncovered interest rate parity (UIP) by the uncovered total return parity condition. The theoretical arguments in favor of the uncovered asset return parity are matched by a number of examples, of which the main group is formed by long-maturity government bonds. Data are examined for the Czech versus German 5 year government bonds, the CZK 10 year bonds of the European Investment Bank vs. German government 10 year bonds, as well as for the Austrian versus US-Treasury 10 year bonds. In both cases, parity seems to verify, although the time horizons and the measures of exchange rate movements, for which it becomes visible, are different. The proposed microfoundation of the uncovered asset return parity uses a model of consumption and investment in an open economy under diffusion uncertainty with soft liquidity constraints. The model is solved by means of the stochastic maximum principle including the adjoint equations for the costate variables. The general equilibrium of portfolio optimizing investors is used to derive a breakdown of the country risk premium present in the uncovered asset return parity relation between a selected pair of fmancial instruments. This allows one to analyze the prevailing beliefs about the long-term exchange rate path. An extension of the basic consumption and investment model to the context of a productive firm issuing its own liabilities to cover liquidity needs, leads to an analogous uncovered yield parity result. I show that the uncovered return parity from the producer perspective is the same as from the consumer and investor perspective. This opens a way for the exchange rate expectation-extraction by means of corporate bonds and other company-specific instruments. In addition, the disparity of returns in international equity markets possesses a certain explanatory power as regards expected competitiveness of domestic and foreign industries.

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://ces.utia.cas.cz/bulletin/index.php/bulletin/article/view/79
Download Restriction: no

Bibliographic Info

Article provided by The Czech Econometric Society in its journal Bulletin of the Czech Econometric Society.

Volume (Year): 6 (1999)
Issue (Month): 10 ()
Pages:

as in new window
Handle: RePEc:czx:journl:v:6:y:1999:i:10:id:79

Contact details of provider:
Email:
Web page: http://ces.utia.cas.cz
More information through EDIRC

Related research

Keywords: uncovered parity; asset prices; portfolio optimization; international CCAPM;

Other versions of this item:

Find related papers by JEL classification:

References

No references listed on IDEAS
You can help add them by filling out this form.

Citations

Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
as in new window

Cited by:
  1. Viktor Kotlán, 2001. "Monetary policy and the term structure of interest rates in a small open economy - a model framework approach," Macroeconomics 0110003, EconWPA.
  2. Tomáš Holub & Jaromír Hurník, 2008. "Ten Years of Czech Inflation Targeting: Missed Targets and Anchored Expectations," Emerging Markets Finance and Trade, M.E. Sharpe, Inc., vol. 44(6), pages 67-86, November.

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:czx:journl:v:6:y:1999:i:10:id:79. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Jozef Barunik).

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.